BASEL III PILLAR 3 DISCLOSURES December 31, 2013 Basel III Pillar 3 Disclosures December 31, 2013 3

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Text of BASEL III PILLAR 3 DISCLOSURES December 31, 2013 Basel III Pillar 3 Disclosures December 31, 2013 3


    December 31, 2013

  • 2

    Table of Contents

  • HomEquity Bank

    Basel III Pillar 3 Disclosures December 31, 2013


    Table 1. Scope of application

    HomEquity Bank (the Bank) is a federally regulated Schedule I bank, incorporated and domiciled in Canada. The Bank’s main business is to

    originate and administer reverse mortgages. The Bank also issues guaranteed investment certificates to fund its mortgage portfolio. The

    Bank is a wholly owned subsidiary of HOMEQ Corporation (HOMEQ), a private company. HOMEQ is wholly owned by Birch Hill Equity

    Partners Management Inc., which is the ultimate parent of the Bank. The Bank’s principal subsidiary is CHIP Mortgage Trust. All of the Bank’s

    subsidiaries are directly or indirectly wholly owned.

    Basis of preparation

    This document represents the Basel III Pillar 3 disclosure for the Bank. These disclosures are made pursuant to the Office of the

    Superintendent of Financial Institutions (OSFI) requirements, which are based on global standards established by the Bank of International

    Settlements, Basel Committee on Banking Supervision (BCBS).

    The amounts disclosed in this document are based on the Bank’s annual and interim consolidated financial statements, which reflect the

    financial position and results of operations of the Bank consolidated with the financial position and results of operations of its subsidiaries.

    The annual consolidated financial statements have been prepared in accordance with International Financial Reporting Standards (IFRS) as

    issued by the International Accounting Standards Board (IASB), including the accounting requirements specified by the OSFI, and reflect,

    where necessary, management’s best estimates and judgments. This report is unaudited.

    Risk Management

    The Board of Directors (Board) has developed and approved a Capital Management Policy (CMP) in accordance with the Board-approved Risk

    Appetite Framework (RAF). The policy addresses minimum regulatory capital requirements as prescribed by regulators and internal capital

    targets as per the Board-approved RAF, which allows for the appropriate allocation of capital to meet the Bank’s strategic goals. The CMP

    dictates that capital be adequately maintained by the Bank.

    Adherence to the CMP ensures that the Bank has sufficient capital to maintain its operations based on current activities, expected future

    business developments and the possibility of various disruptive or adverse scenarios based on the Bank’s stress testing program. Such stress

    testing scenarios include periods of economic downturn and/or asset re-pricing. In addition, in accordance with the Bank’s annual strategic

    planning, a 3-year forecast is prepared and provides guidance as to the type and extent of capital that will be required over this period of


    The Bank’s Asset Liability Committee (ALCO) ensures adherence to the policy on at least a monthly basis and the Conduct Review and Risk

    Management Committee (CRRMC) of the Board ensures capital management in accordance with the Policy on at least a quarterly basis.

  • HomEquity Bank

    Basel III Pillar 3 Disclosures

    December 31, 2013


    Table 1. Scope of application (continued)

    The Bank uses the annual Internal Capital Adequacy Assessment Process (ICAAP) to determine the quantity and quality of capital to conduct

    its business activities. In preparing the ICAAP, the high risk areas established in the Enterprise Risk Management Framework (ERMF) are

    subject to stress testing which incorporates assumptions established in the annual strategic planning process. The results of the stress tests

    help to determine the quantum of capital required to enable management and the Board to set capital levels appropriate with the Bank’s


    The Bank’s CRRMC is responsible for overseeing the types of risk to which the Bank may be exposed and of the techniques and systems used

    to identify, measure, monitor, report on and mitigate those risks. It is also responsible for reviewing capital management plans recommended

    by Management. The Bank’s stress testing program is reviewed with the CRRMC by Management on a quarterly basis and the ICAAP is

    reviewed annually prior to recommendation by the CRRMC to the Board for approval.

    Corporate Governance

    The Bank maintains a rigorous corporate governance structure as follows:

    • Board of Director’s Oversight

    • Conduct Review and Risk Management Committee

    • Audit Committee

    • Corporate Governance and Compensation Committee

    The Bank also has independent oversight functions which include a Chief Risk Officer, a Chief Compliance Officer and a Chief Anti-Money

    Laundering Officer that report directly to the CEO and the CRRMC.

    The Board seeks to achieve long-term sustainable risk adjusted growth in order to ensure the health of the Bank and the stability of earnings

    while protecting the Bank’s well respected brand name and reputation, the interests of its depositors and customers and investors. The Board

    is in support of the Bank increasing new mortgage originations and long-term sustainable portfolio growth with increased profitability and

    improved Return on Equity while managing and maintaining all the associated potential risks with prescribed regulatory limits.

    Business risks

    As a result of the Bank’s business model and the terms and conditions of a reverse mortgage, the most material risks faced by the Bank are as

    listed below:

  • HomEquity Bank

    Basel III Pillar 3 Disclosures

    December 31, 2013


    Table 1. Scope of application (continued)

    Underwriting risk

    Provided the homeowner is not in default, the right of the Bank to receive principal and interest when due under the reverse mortgage is

    limited to the realized value of the property. Underwriting risk is the potential for financial loss if the assets as currently reflected on the

    Bank’s balance sheet become impaired and not fully recoverable. In particular, this can result from a significant and persistent drop in real

    estate values and/or customers choosing not to repay their mortgages for an extended period of time. The Bank has developed reverse

    mortgage underwriting criteria which provide reasonable loan to value ratios for the homeowner while seeking to provide assurance that the

    value of the related property upon maturity will be sufficient to repay the reverse mortgage.

    Competition Risk

    The Bank is Canada’s only national underwriter of reverse mortgages, however there are companies in Canada that offer other alternative

    products that may compete with the Bank. It is also possible that at some time in the future, banks, other financial services companies or

    foreign held reverse mortgage providers may decide to enter the market in direct competition to the Bank. The Bank believes that it has

    established a defensible competitive advantage as a result of its low cost funding, proprietary data, internally developed systems and its

    established brand recognition and marketing network.

    Funding and Liquidity Risk

    Funding and liquidity risk can occur as a result of the uncertain timing of reverse mortgage cash flows and the Bank’s reliance on raising funds

    by the issuance of guaranteed investment certificates and medium-term notes. The Bank has a diversified range of funding sources and has

    created policies and procedures to ensure that cash flows are accurately predicted and monitored. It also maintains a sufficient amount of

    liquid assets to fund its anticipated loan commitments, operations, deposit maturities and interest payments should a shortfall arise

    Interest Rate Risk

    The Bank’s operating margin is primarily derived from the spread between interest earned on the mortgage portfolio, and the interest paid

    on the debt and deposits used to fund the portfolio. Risk arises from the Bank’s assets and liabilities having mismatched re-pricing dates,

    being referenced to different underlying instruments or when the long term expectation of the quality of assets diminishes. The Bank has

    adopted hedging practices to maintain a relatively stable spread between interest earned on the mortgages and interest paid on the highly

    rated debt used to fund them.

    Media and Reputation Risk

    Management is aware of the potential negative effects of media and reputation risk exposure. The Bank has implemented complaint and

    incident resolution processes to mitigate these potential risks.

  • HomEquity Bank

    Basel III Pillar 3 Disclosures

    December 31, 2013


    Table 1. Scope of application (continued)

    Operational Risk

    Operational risk can arise through breakdowns in internal controls and corporate governance, resulting in financial loss. The Bank has

    implemented policies, procedures and internal controls to detect, prevent and manage business activity and to control operational risk.

    Regulatory Risk

    Regulatory risk arises from a financial institution’s non-compliance with applicable laws, rules, regulati